Looking for Light in Ericsson Results, but It’s Getting Dimmer

Ericsson’s Q4 2017 results showed signs of progress, including significant adoption of its 5G-focused Ericsson Radio System (ERS), an improved position in the Chinese market, and the elimination or completion of a dozen unprofitable and/or non-strategic services engagements.

Unfortunately, the weak results, coupled with continued management upheaval, paint a picture of a company that remains adrift despite replacing a significant portion of its leadership team in the past 18 months.

Ericsson released its Q4 2017 financial results January 31, and as the company had already forecast, it was mostly bad news, particularly when it comes to reported results which reflected a 12% decline in revenue and a painful -34.5% operating margin compared to -0.3% in Q4 2016 and -10% in Q3 2017. However, in the spirit of seeing the light at the end of the tunnel, there was some good news to offset the bad. To be clear, however, some of the news was just bad.

Good news: After adjusting for currency fluctuations and comparable units, the year-to-year decline was just 7%.

Gross Margin:

Bad news: Reported gross margin of 21% in Q4 2017 was down from 26.1% in Q4 2016.

Good news: After factoring in one-time charges for restructuring, asset write-downs and provisions for project adjustments, gross margin would have been a relatively healthy 29.9%. This is an indication that once the restructuring is complete, the remaining operations should be well positioned for profit.

Operating Margin:

Bad news: Reported operating margin was a concerning -34.5%, down from -0.4% year-to-year and -10% sequentially.

Good news: After factoring for the aforementioned one-time items, operating margin would have been 0.7%.

Bad news: Even after factoring in one-timers, the company would be only barely profitable.

Good news: Part of the reason operating margin remains low is that the company continues to invest aggressively in R&D to ensure it remains at the cutting-edge from a technology perspective. In total, Ericsson invested nearly $5 billion on R&D in full-year 2017, up 20% from 2016. Ericsson expects to continue to increase R&D in 2018, especially in Networks.

Good news: Gross margin improved year-to-year thanks to a higher share of software sales and success driving out operating costs.

More good news: The company is now seeing an increasing majority of its sales on Ericsson Radio System, which is crucial for the company’s survival in 5G and should help continue to boost margins. ERS has been part of the reason that Ericsson believes it has regained share in the important Chinese market, which has accounted for 70% of RAN sales industry-wide in the past several years.

Good news: The company reported progress in renegotiating 10 unprofitable contracts to ensure that they will be profitable for Ericsson.

Bad news: There are still 19 contracts remaining to be renegotiated, meaning Ericsson’s Managed Services unit will continue to be unprofitable through 2018.

Digital Services:

Really bad news: Ericsson’s Digital Services unit saw a 9% revenue decline year-to-year in Q4 2017 and, more significantly, continues to record significant losses. In Q4, Ericsson’s operating loss in Digital Services was almost as much as the revenue it generated.

Good news: Factoring in one-time items, Digital Services operating margin would have been -21%, a vast improvement over the reported margin of -96.7%.

Bad news: A -21% margin is still really bad.

More bad news: The company is in the process of completing or exiting 45 contracts but has only completed this process on two contracts, meaning that while margin improvement will begin to emerge in H2 2018, the process of working through 45 contracts, many with high-value customers, will likely extend through the end of 2019.

Even more bad news: Ericsson announced it will be replacing its head of Digital Services, Ulf Ewaldsson, during this crucial restructuring period and has not yet identified a permanent replacement.

In summary, Ericsson’s Q4 2017 results reflected both the current challenges the company is facing as well as a glimpse of a brighter, more profitable future. However, for many Ericsson operator customers – which are no doubt rooting for it to succeed – the continued upheaval among key executives since the departure of former CEO Hans Vestberg in July 2016 does not instill confidence that the company is properly positioned yet to execute on its sunny 2020 profitability goals.